“I once was lost, but now am found,
Was blind, but now I see.”
For those of you involved in the lending ecosystem, you either were at LendIt or you should have been at LendIt. The annual gathering of “all things lending” was over 3,500 strong this year and the agenda was chock full of interesting topics and speakers. It was a well run and fantastic show.
With this said, the mood was much more somber than in years’ past and for all the right reasons. It was a conference focused on whether or not the next generation lending companies could adapt their models to today’s funding environment. It was a conference about Banks wanting to Partner with the next generation players as a means to serve their customers changing needs. And it was a conference that was chock full of “what’s next” vs. “what’s now” conversations.
And while there were many little insightful nuggets that I took away from the conference, I can truly say that one and only one thing stood out that I can’t shake. It’s simple yet profound. And in my truthful opinion this one thing is the key to simultaneously internalizing today’s problems while setting up the industry for its next wave of innovation.
ALL LENDING BUSINESSES ARE CAPITAL INTENSIVE WITH NO EXCEPTIONS
At their core, all loan originators advance cash to borrowers today in return for a stream of revenues that will vary based on future market conditions and economic scenarios. An originator might decide to hold on to the stream of revenues which will require having capital to back the loans or it might decide to sell the stream of revenues to someone who has enough capital to back the loans. Either way, lots and lots of capital is flowing from lenders to borrowers and there’s nothing that can be done about it. Capital is the peanut butter and the jelly in a PB&J sandwich. Without capital there are no loans. Without $20B of capital, our industry wouldn’t have been able to make $20B of loans last year. And without $100B of capital, our industry won’t be able to make $100B of loans in the future. Full stop.
So if lending requires massive amounts of capital as table stakes, why would any non-Bank institution want to throw their hat in the ring? Why would venture money be interested in the category? And why would industry experts abandon their cushy jobs to found companies in the space? The answer is simple:
IF STRUCTURED CORRECTLY, THE ANNUITIES GENERATED BY LOANS ARE ATTRACTIVE TO NON-BANK INSTITUTIONS AND MANY OF THESE INSTITUTIONS HAVE VERY DEEP POCKETS AND ARE LOOKING FOR ADDITIONAL INVESTMENT OPPORTUNITIES
This statement can be broken down to define what the job of a non-Bank lender should be. And the “first principles” that result can be used as a litmus test to determine which businesses models are well constructed.
1) Marketing: Efficiently find customers who want to borrow
2) Structuring/Underwriting: Manage approve, decline, credit availability, collateral requirements and pricing decisions to create a stream of future cash flows
3) Projection: Forecast cash flows under a variety of future scenarios
4) Monitoring: Report on results and make appropriate adjustments for future loans
5) Servicing: Ensure customer satisfaction and collection of payments
6) Capital Markets: Find deep sources of capital that want the output of jobs 1-5
The conclusion is that if you aren’t the primary source of capital used to back loans, you have to extract rent from the system based on your ability to efficiently find borrowers and structure attractive future revenue streams. If you aren’t generating attractive profit margins it means you aren’t good at efficiently finding customers or you’re not extracting enough value for brokering transactions. If you aren’t good at finding capital to back your production then you’ve either structured the wrong cash flows or you’re talking to the wrong sources of capital.
So you might be thinking: “Why lend?” I say: “Why not?” We live in a world where people want to buy things today and pay for them tomorrow. There’s gigantic demand for borrowing money that will never go away and lending is a great business if managed correctly. Just don’t forget that you need to find a dollar of capital to lend a dollar to a borrower and there are no exceptions to this universal law. Full stop.